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Don't Let Alternative Minimum Tax Sneak Up on You


Did you exercise incentive stock options last year, pay a lot of state income tax or claim deductible medical expenses for 1999?

If so, it's time to worry. You're at risk of being subjected to the dreaded alternative minimum tax, a little-known form of federal taxation that is creeping up on an increasing number of Americans. The number of taxpayers subject to the AMT has more than quadrupled in the last decade.

The tax was once aimed at the very rich, but today the AMT hits roughly 1% of all taxpayers with income between $50,000 and $100,000 and 4.5% of those earning between $100,000 and $200,000, according to CCH Inc., a tax research and publishing firm in Riverwoods, Ill. By 2009, the AMT is expected to affect 9 million Americans, whose tax bills will swell by $19.8 billion as a result.

Here are common questions about the tax.

Question: What is the AMT?

Answer: The alternative minimum tax was instituted in the late 1970s, when top tax rates hit 90% and numerous tax shelters offered huge write-offs for the wealthy. The aim of the AMT was to ensure that wealthy people actually paid tax, regardless of how cleverly they sheltered their income.

To achieve this, Congress created a separate, parallel system that removes a number of itemized deductions but imposes tax at a lower rate.


Q: Who is affected by it?

A: Theoretically, any taxpayer who earns more than a set amount--$45,000 for a married couple and $33,750 for a single filer--and claims itemized deductions must figure their tax via the ordinary method by filling out Form 1040 and Schedule A. Then they must calculate their taxes a second time by filling out Form 6251, which calculates their tax liability via the AMT. Taxpayers then use the two forms to compare their liability and pay whichever tax is higher.

In reality, many taxpayers have never heard of the AMT and few bother to calculate it. Those who know about it often figure they don't need to mess with it, because they're not among the highflying, tax-shelter-buying group Congress was targeting. But increasingly, these taxpayers are getting hit with the AMT.


Q: What pushes a middle-income family into AMT territory?

A: Generally, a combination of so-called preference items--accountant-speak for deductions that are treated differently under the AMT system than under the ordinary tax system. These preference items are subtracted from your income under the ordinary tax system, and they're excluded as deductions when you figure your tax via the AMT.

There are seven common preference items that can push unsuspecting taxpayers into the AMT:

* Sizable state income taxes deducted on your federal return.

* Deductible medical and dental expenses.

* Incentive stock options. (When you exercise an incentive option, the difference between the exercise price and the current market value of the stock is an AMT preference item. With non-qualified stock options, the more common variety, you must pay income tax on your gain at the time of the exercise, so AMT is not an issue.)

* A home equity loan that was used not to improve your property, but to buy other items, such as a car or boat, or to pay off other bills.

* An unusually large number of personal exemptions. (For instance, if you have six or more children, and/or parents or other relatives that you claim as dependents.)

* Substantial miscellaneous itemized deductions.

* Depreciation of a business or investment property.


Q: What itemized deductions don't put you at risk of the AMT?

A: Contributions to charities and retirement plans and mortgage loan interest are not considered preference items.


Q: If I think I'm at risk of the AMT, what do I do?

A: Hire a qualified tax accountant or buy a tax software program. The major software programs will automatically calculate the AMT. And any seasoned tax specialist should know it well.

If you prefer to go it alone, be prepared for some arduous work. The AMT form assumes you know many of the fine points of U.S. tax law, such as the difference between ordinary and AMT depreciation schedules, ordinary and AMT deductions for investment interest, etc. If you don't, you'll need to spend hours searching through tax guides to fill out the form properly.

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